Before I made the transition to the sales side of real estate, I worked for a small builder/developer building new construction homes. The business model was primarily spot lot and entry level homes, and I learned so much from this working experience that in 2010 I decided to pool investor capital and build myself. Interestingly, my first five listings as an agent were houses that I had built with investor capital.
While I’ve flipped a lot of houses over the years, building remains my preferred method of investing (aside from buying cash flow rentals) for the reasons mentioned below.
I rarely see investors build new construction homes themselves, usually the people building are smaller or larger builders, and that’s about it. I’d like to share my knowledge and expertise on how to the ways that building houses can make you rich so that you may consider adding this strategy to your business plan.
Banks are often more willing to lend at higher LTV (Loan-To-Value) on new construction homes than they ever would on a flip (and few banks will lend on flips in general). A few years ago it was not very easy to get a new construction loan. Since the recovery, banks have been more willing to lend and they’ve started lending on new homes and then land development shortly thereafter.
Most banks will loan up to 75% of the overall project cost, and their rates are around 6% on what is borrowed for that month, so it’s relatively inexpensive money.
The leverage of choice for most flippers is limited to hard money loans (at somewhere between 10-12% interest plus points) or raising capital from other investors.
Ease of Raising Capital
If I ever so slightly mention that I have a new construction project, the first question I get is “are you taking on investors?” Investors love the idea of investing in a new construction project where their capital is in a controlled environment and there are high profit margins when it’s done.
Of all of the new construction projects I’ve done, I’ve never had to use any of my own capital to fund the project. My contribution to the project has been finding the property, deciding what to build, securing bank financing and marketing the project for resale.
A good project manager can be hard to come by, though if you have experience in building then it’s safe to say you’ll have an easy time funding the project.
While each project is different, there are often much higher profit margins in new construction homes than there are in flips.
Why would the profit margin be so much higher?
- Less competition – I previously mentioned only small or large companies build, so there are fewer builders out there than there are flippers. It’s also fairly difficult to get financing on just a single lot for a regular homeowner who wants to build their own home, so really the buyers that are left are builders.
- There are fixed costs for the house itself, though the land price is where the profit comes into play. An experienced builder knows what the permitting fees are in an area, and what the house will cost, so really they are just negotiating on the land price and vacant land rarely sells for 100% of list price, unless it was under priced to begin with.
- For a builder who builds a few houses at a time, they can enjoy discounted pricing for the subcontractors.
- New homes will always sell for more than a “used” home, and if the finishes were high end and the house was built in a desirable area the new home or homes often create their own comp.
Building for Investors
I’ve done many deals where I used my building skills to build for other investors who funded the project. I was able to earn a percentage of the profits and they were able to make a fantastic return.
This is just another strategy to earn an income in building.
Multi-family Builds Often Return All of the Initial Capital
Over the years I’ve built a lot of duplexes. If you can get the land at the right price, and keep the building costs down, often times all initial capital would get recouped once permanent financing was completed.
Here is a breakdown on how this would work:
Land Price: $125,000
Permits/total building costs: $325,000
Construction loan down payment 25%: $112,500
New Appraised Value: $600,000
Max LTV @ 75%: $450,000
Since the property is now valued at $600,000 for a brand new duplex, the initial capital invested of $112,500 is repaid and you now have a brand new duplex with 25% equity and no money down.
The More You Build The Better the Pricing You Get
This is a more obvious benefit of building multiple homes and projects.
When you build momentum in building and have multiple builds at once you are able to negotiate better pricing with subcontractors and vendors. The better the pricing the less the cost to build is which directly affects the bottom line.
Spin Off Business Opportunities
I know many builders who later started their own sheetrock companies, excavation companies, and sometimes purchase their own staging to net more on their projects.
I see this as a more risky venture unless these companies subcontract for other builders, though I do know some who have seen great success in this option.
Very high profit margins and an end buyer to boot. The downside to this option is it can be very time consuming, and there is a buyer who may want changes along the way or question parts of the project.
There Is Always a High Demand For New
Much like cars, new houses always sell for more than their used counterparts. Buyers love the idea that they get to be the first owners of a home, and that there are warranties that come with them.
I’ve also seen builders make their own comps and raise values in an entire area.
A Builder Can Choose What to Build
I have always looked for holes in the market. I want to build something that does not exist, though something that had a high demand. This allows me to set my pricing on a high demand product with little to no supply.
Ability to Pre-sale
This opportunity is similar to building custom, however there is more control on the building side. Often times buyers are given a few pre-set options to choose from including color boards and small design changes.
Pre-sales help builders get momentum in a plat, and sometimes a bank will require a builder get a pre-sale purchase contract before they will lend money to the builder to build. Many new builders start this way.